Peer Firm Financial Reporting Behavior During and After Aggressive Financial Reporting Within Their Industry

In the United States, numerous examples exist of SEC registrants engaging in aggressive financial reporting. These instances often attract the attention of stockholders and regulators, as evidenced in existing research investigating the consequences of indulging in aggressive financial reporting. In addition to known cases of aggressive financial reporting, numerous examples exist of non-enforced firms engaging in aggressive accounting practices. However, it is unclear if the peer firms (those firms not directly involved in the nefarious accounting activities) respond to aggressive accounting by mirroring or ignoring such behavior. Additionally, when the enforcer is active within their industry, it is unclear if peer firms alter their accounting practices in hopes to avoid attracting the regulator's attention, or if the peers take the position that their financial reporting is according to GAAP and, therefore, there is no perceived risk of an imminent investigation into their respective firms. Using a unique set of data, I analyze peer firm behavior before, during, and after an industry firm engages in aggressive accounting practices. The findings suggest that peer firms trade a decrease in earnings management via discretionary accruals for an increase in real earnings management when an aggressive firm ceases its aggressive financial reporting. Further, the evidence reveals that the knowledge of SEC enforcement activity in a Peer Firm's industry is the greatest motivator to report lower earnings management, both via discretionary accruals and real earnings management.